Wealth Managed - 24 October 2016

By David Lane - October 24, 2016

Share markets are entering a volatile period. Traditionally, October and November can be a skittish period as we move toward the end of the calendar year, when the seasonality of markets takes hold and December is usually strong.

This year, there are a number of significant events that could well add to the volatility and uncertainty of global markets. 

We are less than three weeks away from the US Election – arguably the most anticipated election in recent history (predominantly for the wrong reasons). The final debate was held last week, and it appears that Hillary Clinton has an unassailable lead. If the polls are correct, and Hillary Clinton does become the first female President of the US, global markets will likely react positively. We would expect to see a rally in the US Dollar, and in US share markets. President Clinton is viewed as being a more stable, less unpredictable influence who is often touted as a “friend of Wall Street”.

As we get closer to the election date, we may actually see these positive influences begin prior to polling day. Markets have a tendency to “buy on rumour, sell on fact”, and if it appears that Hillary will be the winner, investors may begin to move in advance of the result.

The days, weeks and months following the election may, however, add to the uncertainty that has surrounded the US political climate for the last few years. Possibly more important than the President is the make-up of the Congress. President Obama has faced a Republican Congress that has sought to block his moves at every opportunity. A hostile Congress could make it difficult for President Clinton to enact changes. However, the fractured nature of the Republicans given their unorthodox and surreal campaign may well deliver a Democratic landslide, which would allow the President and her party to actually govern.

From an investment perspective, the election is an interesting sport, but really only a pre-game warm-up to the main event. For many economists, analysts, fund managers and investors, the most powerful woman in the world is actually Federal Reserve Chair, Janet Yellen. Her influence on global markets with the imminent decision on official interest rates will be significant. While the Federal Reserve does meet on November 1-2, it is widely acknowledged that a decision on rates will be deferred until the meeting after the election. This meeting on December 13-14, where most are expecting a rate rise of 0.25%, will arguably have a bigger impact on markets than the election result.

While we saw a severe and negative reaction to the last US official rate rise (in December 2015) in the first quarter of this year, it is unlikely that this year we will witness such a severe sell-off. The movement of the US Fed has been one of the most hotly discussed topic of the year – even though for all of calendar 2016 so far it has remained steady.

While the strengthening of the economy is being cited as the reason to lift US interest rates, the reality is that rates have been at such low levels for so long, that it is ‘about time’ they begin raising rates. Economic growth in the US is still lacklustre and government debt is rising. While US corporates have been doing well over the last 5 years, the strengthening of the USD has begun to have a dampening impact on earnings, as over 50% of the earnings for the companies in the S&P 500 come from outside of the US.

As has been the case so far this year, the Federal Reserve will most likely take a very prudent and cautious stance when it does raise rates. The language surrounding the move will be designed to not scare markets into thinking the move will be the first of a number of swift moves.  Ms Yellen will be reassuring us all that the interest rate cycle will continue to be ‘lower for longer’.

This week’s data highlighted that China and the US are requiring increasing levels of debt to drive economic growth, a trend that increases risks within the global economy and financial markets and hence provides reason for caution. 

The RBA are beginning to voice a level of concern on this matter, particularly in relation to China, stating in their recently published half yearly financial stability review that the “potential for a disruptive adjustment in China remains pronounced, given the ongoing increase in debt at a time when the pace of economic growth has been moderating”. This echoed similar recent warnings from the International Monetary Fund and the Bank of International Settlements on the matter.    

The RBA will also be concerned about the loss of jobs (particularly the full time jobs) reported last week and the falling participation rate which both point to softness in the domestic economy despite the lower headline unemployment rate. 

While the RBA have often used Melbourne Cup Day as the day to make a move with official interest rates, we believe that a change to Australian rates next Tuesday is more of an outside chance than an each-way-bet. With the US election looming, and the prospect of a US rate rise in December, Phillip Lowe and the board are expected to hold steady, and allow the US Fed to assist the AUD lower, as the USD is likely to strengthen if Hillary Clinton becomes President and Janet Yellen raises US rates.

News in Review

  • Australia's unemployment rate edged down to 5.6% (from 5.7%), despite the loss of 9,800 jobs, as the participation rate fell from 64.7% to 64.5%. Within these figures, it was estimated that 53,000 full time jobs were lost while 43,200 part-time jobs were gained.
  • The Chinese economy continued its expansion at 6.7% p.a in the third quarter, in line with Beijing’s full-year target of between 6.5% and 7%. Behind this was a surge in the money supply (the M1 measure rose 24.7% for the year) driven by real estate sales and mortgages.   
  • The US deficit increased for the first time since 2011 due to a slowdown in the growth of federal revenues as well as rising government spending. The budget shortfall widened to $587 billion in the fiscal year that ended Sept. 30, up 34% from the previous fiscal year.
  • The cost of living in the U.S. rose at the fastest pace in five months on shelter and energy prices, pushing inflation closer to the Federal Reserve’s goal. The Consumer Price Index (CPI) increased 0.3% in September from the previous month, matching the median forecast of economists, after a 0.2% gain in August.
  • Chinese industrial production weakened unexpectedly in September, while broad measures of consumer spending and fixed-asset investment improved. Industrial production, a broad measure of factory output, rose at an annualized 6.1% in September from a year earlier.
  • Euro area annual inflation was 0.4% in September 2016, up from 0.2% in August. In September 2015 the rate was -0.1%. European Union annual inflation was also 0.4% in September 2016, up from 0.3% in August.
  • Output at US manufacturers rose for the third time in four months on production of consumer goods and construction materials, a sign the industry is recovering from a prolonged spell of weakness. The 0.2% gain at factories, which make up 75% of production, followed a 0.5% decrease the prior month.
  • Sterling rose on Tuesday, spurred on by higher than expected UK inflation data that cast doubt on whether the Bank of England will still consider easing monetary policy again this year. The CPI rose by 1.0% in the year to September 2016, compared with a 0.6% rise in the year to August. The rate in September 2016 was the highest since November 2014.
  • UK jobless rate held steady at 4.9% for the third straight time in the three months to August of 2016, in line with market expectations. It stood at the lowest level since July to September 2005, as the number of people in work and the number of unemployed.

Company News

  • In its market update Healthscope stated that it has experienced "slower than expected" hospital revenue growth in the September quarter, highlighting recent publicity of healthcare affordability. The company stated that if Q1 trends persist throughout all of FY17, it is likely that the earnings of its Hospitals division will be flat year-on-year. Healthscope noted that falling confidence in private health insurance products and increasing numbers of people just buying ‘junk’ policies to avoid penalty tax is also having an impact. In addition, it finds itself competing with public hospitals which currently undertake 770,000 private patient episodes a year.
  • Two of Australia's biggest listed gambling businesses, Tabcorp and Tatts, have agreed to merge and create an $11.3 billion giant which will control more than 90% of Australia's totalisator betting and generate revenues in excess of $5 billion. The merger expected to be complete Mid-2017.
  • Crown has wiped $500m from the value of major shareholder James Packer's stake in the casino operator, as analysts warned the company could face a profit hit of up to 5% if there is a wider crackdown on China's VIP gaming markets. Crown said in a statement to the ASX that it believes the executive vice-president of its VIP international business, Jason O'Connor, has been detained by Chinese authorities in a crackdown that has seen 18 Crown staff detained.
  • BHP reported a slide in quarterly iron ore production, but saw early signs of a recovery. The company said that its quarterly iron ore production was 58 million tons for the September 2016 quarter, compared with the 61 million tons produced in the year-earlier period. Fiscal 2017 guidance remained between 265 million and 275 million tons.

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